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Musings From The Oil Patch by Eoin Treacy

Musings From The Oil Patch

Thanks to a subscriber for this edition of Allen Brooks ' report for PPHB. Here is a section on energy independence:

In late September, the Energy Information Administration (EIA) released data showing weekly domestic crude oil production had reached the highest level since January 1997 – some 15 years ago. Reports are that despite the slowdown in drilling in the Bakken formation in North Dakota and Montana, production there should continue to rise during the second half of 2012. Two charts demonstrate the significance of the increase in domestic production. The first chart (Exhibit 8, next page) shows the weekly estimate of domestic crude oil production since January 1990 with a red line showing how the September 21 data compares with production in early January 1997.

The second chart (Exhibit 9) shows the weekly domestic production and the weekly oil import figures. That latter weekly data series is susceptible to considerable fluctuation due to market conditions and weather impacts on tanker operations. What is obvious from this chart is the peak in oil imports and subsequent decline coinciding with the bottoming of weekly oil production and its subsequent increase.

The decline in oil imports appears to be significant, but part of the explanation is that overall oil demand has dropped. That is shown by the chart in Exhibit 10. The chart shows total petroleum consumption and the weekly demand for gasoline. Gasoline demand shows slowing growth in 2007-2008 and then the beginning of a decline associated with the recession and changes in vehicle miles driven. The overall decline in petroleum consumption is largely explained by this decline in gasoline consumption. Due to this relationship, we know that to understand the future of the oil market in the United States, one must watch gasoline consumption and domestic oil production. Any change to their recent trend – either up or down – will impact the nation's goal of achieving energy independence.

The EIA's recent data showed that America has achieved 83% energy self-sufficiency. Again, the explanation for this high level is due to the combination of flat consumption, rising domestic production (oil, gas, coal and renewables) and declining imports of oil and LNG. Optimists expect domestic energy production to continue to grow, but that assumption depends on governmental energy policies and the nation's energy consumption, which in turn depends on the economy's growth.

Yes, the nation is knocking on the door of energy independence, but some of the recent gains are the result of weak energy demand. Reaching a higher level of national energy self-sufficiency may actually signal that we are more a hostage to a weak economy with potentially significant social ills rather than having unlocked our true domestic energy potential. Reaching energy independence will likely remain an elusive goal for many years.

Eoin Treacy's view It has been our contention for almost two years that if the USA follows the correct policies then energy independence is now within its grasp. This will depend on lower oil consumption through technological developments, changing living habits and substitution, especially for natural gas, but also coal and renewables.

The paradox of asset markets means that as energy independence becomes a more realistic ambition, it will become more difficult to sustain not least because of increased demand fostered by comparatively low natural gas prices.

Natural gas almost doubled from its April low and offers an interesting example of how supply is affected by pricing. A great deal of additional volume becomes economic above $4 and this level therefore represents a considerable hurdle. The other side of the equation is that at the lows posted earlier this year, significant supply had to be shuttered because of pricing. This condition suggests that natural gas pricing is likely to remain volatile for the foreseeable future. Prices encountered resistance yesterday near $3.60 and will need to hold above £3.25 if the benefit of the doubt is to be given to the upside.

Gasoline prices have been quite volatile over the last month particularly at the contract change but continue to weaken on aggregate. A sustained move above $300 would be required to question potential for an additional test of underlying trading.

Heating Oil retested the upper side of its 18-month range last week and at least paused. A clear upward dynamic will be required to question current scope for some additional weakness.

West Texas Intermediate crude oil pulled back by more than $10 in September but stabilised in the region of $90 this month and would need to sustain a move below that level to question potential for some additional firming.

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